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House expected to approve budget resolution today and unveil its tax plan next week
ECB QE tapering expected to be announced today
ECB’s tapering means less global liquidity
7-year T-note auction to yield near 2.28%%
U.S. unemployment claims returns to strength after hurricane disruptions

House expected to approve budget resolution today and unveil its tax plan next week — The House today is expected to approve the same 2018 budget resolution that the Senate passed last week, thus finalizing the resolution. That resolution kicks off the reconciliation budget process that will allow Congress to pass a tax reform bill by a majority vote and avoid the possibility of a filibuster by Senate Democrats. The House is expected to officially announce its budget plan next week, although details could certainly leak earlier.

Speaker Ryan plans for the House to pass a tax reform bill before Thanksgiving, then sending the bill over to the Senate. After the Senate passes a tax reform bill, then a conference will try to merge the plans into a single bill that can be passed by both the House and Senate. The bill will then be sent to President Trump’s desk for his signature.

The limited amount of time before the Republicans’ stated deadline of year-end is why the betting odds for a corporate tax cut by the end of 2017 remain very low at 23%. However, the odds in our view are substantially better for at least a watered-down tax cut by early 2018.

ECB QE tapering expected to be announced today — The market consensus is that the ECB at its meeting today will cut its QE program in half to 30 billion euros per month from the current level of 60 billion euros per month, and that the program will stretch over the first nine months of 2018. The ECB is expected to stress in post-meeting comments that it will not raise interest rates until well after its QE program is over. The market consensus at present is that the ECB will first lift its -0.40% deposit rate by a notch in Q1-2019 and its 0.00% refinancing rate by a notch in Q2-2019.

ECB’s tapering means less global liquidity — The ECB’s tapering of its QE program in 2018 means that the ECB will still be injecting net liquidity into the global banking system, but at a slower rate. The reduced liquidity injection will be a mildly bearish underlying factor for European stocks and bonds. ECB tapering will also be mildly bearish for the U.S. T-note market since European investors will face less pressure to buy U.S. Treasuries when there are more European government bonds available to buy as the ECB reduces its purchases.

The 10-year German bund yield has risen fairly sharply by +11.5 bp in the past week but remains very low in general at 0.482%, well below the 1-3/4 year high of 0.603% posted in July. The German bund yield is likely to rise today if the ECB tapers QE faster than expected or if the markets are not satisfied with the ECB’s assurances that rates will not be raised until well past the end of QE. Meanwhile, the European stock market will see mildly less support from the ECB’s smaller 2018 QE program, but the good news is that the ECB will still be injecting some 300 billion euros of new liquidity into the financial system during 2018.

Markets wait to see if Catalan parliament will declare independence as Spanish Senate drops the Article 155 hammer — The Spanish Senate on Friday is scheduled to vote to approve using Article 155 of the Spanish constitution to strip Catalonia of its autonomy and take political control of the region. However, the Catalan parliament is expected to meet on Thursday and Friday and might decide to declare independence and/or call for new elections. A Catalan independence declaration would be invalid under the Spanish constitution but would nevertheless inflame the situation by putting Spanish Prime Minister Rajoy on the spot about whether to arrest Catalan President Puigdemont.

We continue to believe that the activation of Article 155 is a positive outcome for the markets since it will reduce legal uncertainty and will allow the Spanish government to sidestep the separatist movement for the time being. However, the activation of Article 155 is also likely to cause civil unrest and does not provide a long-term solution.

7-year T-note auction to yield near 2.28% — The Treasury today will sell $28 billion of 7-year T-notes, concluding this week’s $103 billion T-note package. Today’s 7-year T-note issue was trading at 2.28% in when-issued trading late yesterday afternoon, which translates to an inflation-adjusted yield of 0.38% against the current 7-year breakeven inflation expectations rate of 1.90%. The 7-year T-note yield has risen sharply by +43 bp since early-Sep to post a new 7-month high of 2.28% on Wednesday.

The 12-auction averages for the 7-year are as follows: 2.55 bid cover ratio, 4.4 bp tail to the median yield, 20.4 bp tail to the low yield, and 39% taken at the high yield. The 7-year T-note has become the most popular coupon security among foreign investors and central banks. Indirect bidders, a proxy for foreign buying, have taken an average of 68.4% of the last twelve 7-year T-note auctions, which is far above the average of 61.1% for all recent Treasury coupon auctions.

U.S. unemployment claims returns to strength after hurricane disruptions — The unemployment claims data is once again illustrating the strong U.S. labor market. In last week’s report, initial unemployment claims fell to a new 45-year low of 222,000 and continuing claims fell to a new 44-year low of 1.888 million. The claims data has quickly shaken off disruptions from hurricanes in August and September. The market consensus is for today’s initial claims report to show a +13,000 increase to 235,000 (after last week’s -22,000 decline) and for continuing claims to show a +7,000 increase to 1.895 million (after last week’s -16,000 decline).

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